This week’s stock market crash of over 10% is one of the four worst weeks since WWII for stocks. The others were Black Monday 1987, Dot-com bubble in 2000, and the GFC crash of 2008, which was the worst. The 2000 bubble was mainly in tech stocks while the low tech companies were not that badly overpriced, so that crash was less of a comprehensive crisis. The 1987 crash occurred when debt levels were much lower and demographics more favorable. The 2008 banking crash was mainly about financial companies that were stuck with a negative net worth because they made bubble-like loans to the housing bubble, so they were able to respond to central bank QE stimulus and suspension of “Mark to Market” rules. Thus it may be harder for the Federal Reserve to fix this crash than the crash of 2008.
Based on PE10 theory, and many similar metrics, stocks had a PE10 ratio of 34 (where 15 is fair value) at the peak of SP index at 3,393 so they needed to drop in price by about 54% from the peak to about 1,550 to reach fair value. The crash has only just begun. No one knows if the rules will be changed by Congress, allowing the central bank to buy stocks, and then the bubble would be propped up more. However, allowing the Federal Reserve to buy stocks, etc. may be too difficult for Congress to authorize as it would be seen as favoring affluent investors.
PE10 theory is more applicable to moderate growth old tech companies, so the high tech companies need to carefully reviewed to see if their high PE’s are justified. Based on what happened to the Nifty50 tech companies of 1974, which were excellent quality companies, but simply overpriced, they ended up crashing 80% because they had PE ratios of 60 or higher, about 4 times fair value. Many never regained their all-time highs even 25 years later during the great tech boom of 1999. A similar thing occurred in Japan in 1990, and prices never recovered, even though it has been 30 years.
Sometimes the only solution to avoiding a bubble crash is to have a quarantine on your assets and lock them up, metaphorically, in a hotel (short term bonds, etc.) until the stock bubble bursts. Gold is viewed as a safe haven but it went down 3.5% today. Apparently the market feels we are headed into a deflationary crash so investors lack a desire to own gold as a hedge. If the market feels Congress will reflate the economy through massive deficit fueled spending then such an inflationary scenario would make people buy gold and its price would rise.
Investors need independent financial advice about the risks of a bursting stock market bubble.